Monday, November 8, 2010

If you think that the US Federal Reserve's announcement of a $600bn second slug of quantitative easing (QE2 as it has been dubbed) is just what the US and World economies need right now, think again. It is rare that mere monetary manipulation is the springboard for a solid and lasting cycle of productive economic activity. I will allow that an economy that has suffered a shock fall in its money supply, because of major banks going under say and taking depositors's cash with them, could do with an infusion of cash from the central bank. But the US and most of the World is not in such a position.

Bank bail outs and the last lot of QE have stabilised the banking system, at least for now. No depositor in the US or UK lost a penny. Money supply and the velocity with which it has been circulating round the economy, have been growing briskly on both sides of the Atlantic after an understandable slow down in the aftermath of the crisis, caused by a reluctance to lend, borrow, invest and consume in the private sector. Retail price inflation is positive and rising in the US (about 1%, much higher in the UK). The economic recovery is slow but what would you expect if the private sector is working off its excessive debts and banks rebuilding their capital?

So the new money is not filling a hole in the money supply, or warding off the supposed horrors of deflation or needed to refloat the financial system. The Fed chairman justified the extraordinary move by claiming prices are not high enough - he wants high consumer inflation and higher share prices.

“Higher stock prices will boost consumer wealth and help increase confidence, which can also spur spending," Ben Bernanke

So the Fed is printing 600 billion to buy US government debt on top of the 1,700 billion it has already printed to make sure its citizens pay more for what they need to live on and in the hope of a trickledown effect from booming stock markets. But what will happen in practice?

A clue was to be found this week in news reports of a boom in fine wine prices and a new world record for a single bottle:

An 1869 vintage wine of Chateau Lafite-Rothschild was recently sold at auction in Hong Kong for a record 147,020 pounds, leading experts to warn that fine wines could soon become unaffordable. (CityAM)

And this is before QE2. The free money, printing press economics that are being followed by our monetary masters around the globe are predictably fuelling inflation, even though the main consumer indices are reasonably becalmed. The money is finding its way through to speculative property deals, emerging markets, takeovers, precious metals, rents, commodities, luxuries, art - the price of anything that isn't being held down by the deadweight of unemployment misery and industrial ruin.

A tidal wave of money has been unleashed supposedly because we are all suffering from low prices at a time when energy prices are rising sharply and food basics like rice, sugar and wheat are soaring in price. The fact that emerging markets and speculative investments are booming suggests that the excess liquidity is not being invested in real investment in the Western economies but is simply flowing abroad, jacking up the prices of essentials and causing chaos.

I think there is some sort of recovery taking hold in some of the Western countries and am not unrelentingly doom and gloom, but this latest piece of economic policy making beggars belief. I hope the UK doesn't follow suit. And I certainly don't expect a healthy round of balanced economic growth any time soon.